Proposed NBFC norms may strengthen their balance sheets: Moody’s

The Reserve Bank of India‘s current proposal for tighter regulatory framework for non-banking monetary firms may strengthen their balance sheets however is not going to deal with their funding and liquidity points, says a report.

Last week, RBI launched a dialogue paper which proposed a scale-based regulatory method linked to the systemic threat contribution of shadow lenders.

In a report on Monday, Moody’s Investors Service mentioned the proposal will commit the most important 25-30 NBFCs to regulations much like banks concerning capital, credit score focus and governance.

“If implemented, the regulations would result in the companies becoming more resilient to credit shocks. However, the proposals do not address NBFC‘s funding and liquidity, the key credit weakness of the sector,” Moody’s mentioned.

The proposed new laws would end in largely harmonised guidelines between banks and NBFCs on capital and leverage, which would scale back the regulatory arbitrage alternatives for NBFCs towards the banks in their lending choices, it mentioned.

However, adjustments are proposed to the NBFCs’ present lighter liquidity guidelines, the report mentioned.

Banks are topic to strict laws on sustaining a minimal money reserve ratio and statutory liquidity reserve, which aren’t imposed on NBFCs, it mentioned.

“This means the proposal does not address the key weakness of the NBFCs and the sector will continue to pose risks to banks’ asset quality because banks are the largest lenders to the NBFCs,” the report mentioned.

The paper has proposed the regulatory framework of NBFCs based mostly on a four-layered structure- base layer (NBFC-BL), center layer (NBFC-ML), higher layer (NBFC-UL) and high layer.

“If implemented, the largest 25-30 NBFCs will be classified as NBFC-UL and will need to maintain a minimum common equity tier 1 (CET1) ratio of 9 per cent compared with 8 per cent for banks,” Moody’s mentioned.

The NBFCs will want board-approved insurance policies for focus in riskier sectors similar to actual property, which has been a supply of asset high quality issues for NBFCs, it mentioned.

Moody’s expects most rated NBFCs to be labeled as NBFC-UL. The new norms don’t present a lot incentives for NBFCs to transform into banks, which the regulator has envisaged through the proposed adjustments to financial institution possession laws in November 2020, the report mentioned.

The banking regulator is proposing to initially hold the NBFC-top layer empty, however will transfer firms into this class if it sees elevated credit score threat in these firms, it mentioned.

“Those NBFCs will be subject to tighter supervision similar to the prompt corrective action framework for banks,” the report mentioned.